Question

1. International equity markets and Portfolio Management: How to categorize emerging markets; Advantages of cross-listing, how to cross-list, what ADRs are, the types and advantages of ADR. Home bias & reasons for home bias; mutual fund and advantages

Answer 1

Advantages of cross listing:
Some of the advantages to cross-listing includes

1) Market Segmentation:-
Market segmentation is the practice of dividing a large market into clear segments with similar needs. Cross-listing enables firms to divide foreign investor markets into segments which are easy to access. Companies seek to cross-list because they anticipate gaining from a lesser cost of capital.

2)Increased Market Liquidity:-
Cross-listing enables companies to trade its shares in numerous time zones and multiple currencies. This increases the issuing company’s liquidity and gives it more ability to raise capital.

3)Disclosure:-
Cross-listing can decrease the cost of capital via improving the company’s information environment. Cross-listing is associated with better media awareness which increases the quality of accounting information. Listed companies can use cross-listing on markets with strict disclosure requirements to indicate their quality to foreign investors and to supply better information to potential suppliers and customers.

4)Investor Protection:-
Cross listing acts as a linking mechanism used by companies that are incorporated in a jurisdiction with reduced investor protection. These companies commit themselves willingly to higher standards of corporate governance.

How to cross list:-
Cross-listing is the listing of a company's common shares on a different stock exchange than its primary and original stock exchange. To be approved for cross-listing, the company in question must meet the same requirements as any other listed members of the exchange with regard to accounting policies. These requirements include initial filing and ongoing filings with regulators, a minimum number of shareholders, minimum capitalization, and others.

What are ADRs?
An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. depository bank representing a specified number of shares—or as little as one share—investment in a foreign company's stock. The ADR trades on markets in the U.S. as any stock would trade.

ADRs represent a feasible, liquid way for U.S. investors to purchase stock in companies abroad. Foreign firms also benefit from ADRs, as they make it easier to attract American investors and capital—without the hassle and expense of listing themselves on U.S. stock exchanges. The certificates also provide access to foreign listed companies that would not be open to U.S.

Types of ADRs:-
They are categoried into 2 basic types:

1)SPONSORED:A bank issues a sponsored ADR on behalf of the foreign company. The bank and the business enter into a legal arrangement.

2)UNSPONSORED:A bank also issues an unsponsored ADR. However, this certificate has no direct involvement, participation or even permission from the foreign company.

ADRs are additionally categorized into three levels, depending on the extent to which the foreign company has accessed the U.S. markets:

Level I - This is the most basic type of ADR where foreign companies either don't qualify or don't want to have their ADR listed on an exchange.
Level II – As with Level I ADRs, Level II ADRs can be used to establish a trading presence on a stock exchange, and they can’t be used to raise capital.
Level III – Level III ADRs are the most prestigious of the three ADR levels. With these, an issuer floats a public offering of ADRs on a U.S. exchange.

Advantages of ADRs:

1)The American investor can invest in foreign companies which can fetch him higher returns.
2)The companies located in foreign countries can get registered on American Stock Exchange and have its shares trades in two different countries.
3)The benefit of currency fluctuation can be availed.
4)It is an easier way to invest in foreign companies as there are no restrictions to invest in ADR.
5)ADR simplifies tax calculations. Trading in shares of foreign company in ADR would lead to tax under US jurisdiction and not in the home country of company.
6)The pricing of shares of foreign companies in ADR is generally cheaper. Hence it provides additional benefit to investors.

HOME BIAS:-
Home bias is the tendency for investors to invest the majority of their portfolio in domestic equities, ignoring the benefits of diversifying into foreign equities. This bias was originally believed to have arisen as a result of the extra difficulties associated with investing in foreign equities, such as legal restrictions and additional transaction costs. Other investors may simply exhibit home bias due to a preference for investing in what they are already familiar with rather than moving into the unknown.

Reasons for Home Bias:-

Reasons for home bias include:

1)Holding domestic assets can protect domestic investors against domestic risks such as inflation or exchange-rate depreciation.
2)The benefits of international diversification are small relative to the transaction costs involved in buying foreign assets.
3) Information on domestic assets is of better quality than that on foreign assets.

MUTUAL FUNDS:
A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund's assets and attempt to produce capital gains or income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Advantages of Mutation Funds:

1)Advanced Portfolio Management:
When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is used to hire a professional portfolio manager who buys and sells stocks, bonds, etc. This is a relatively small price to pay for getting professional help in the management of an investment portfolio.

2)Dividend Reinvestment:
As dividends and other interest income sources are declared for the fund, it can be used to purchase additional shares in the mutual fund, therefore helping your investment grow.

3)Risk Reduction (Safety):
Reduced portfolio risk is achieved through the use of diversification, as most mutual funds will invest in anywhere from 50 to 200 different securities—depending on the focus. Numerous stock index mutual funds own 1,000 or more individual stock positions.

4)Convenience and Fair Pricing:
Mutual funds are easy to buy and easy to understand. They typically have low minimum investments and they are traded only once per day at the closing net asset value (NAV). This eliminates price fluctuation throughout the day and various arbitrage opportunities that day traders practice.